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CHAPTER 2

Fund Accounting

CHAPTER HIGHLIGHTS

The nature and purpose of fund accounting

The meaning of ‘‘basis of accounting’’ and ‘‘measurement focus’’

The types of funds that governments use

How the funds of not-for-profits differ from those of governments

I n Chapter 1, we set forth key characteristics that distinguish governments and

not-for-profits from businesses and we discussed their implications for accounting and
reporting. In particular we noted that governments and not-for-profits establish their account-
ing systems on a fund basis. In this chapter, we explain the rationale for fund accounting,
describe the main types of funds maintained, and examine the relationships among funds. In
Chapter 3, we show how funds are included in a government’s financial statements.

W HAT IS A FUND?
.............................................................................................................
In business accounting, ‘‘funds’’ typically refers to working capital (current assets less current
liabilities) or selected elements of it (such as cash and investments). But in government and
not-for-profit accounting the term fund has a different meaning.
Fund accounting is a system in which a government’s or not-for-profit’s resources are
divided among two or more fiscal and accounting entities known as funds. As a fiscal (or
financial) entity, each fund accounts for resources, and the claims against them, that are
segregated in accord with legal or contractual restrictions or to carry out specific activities. As
an accounting entity, each fund has its own self-balancing set of accounts from which separate
financial statements can be prepared. Governments and not-for-profits customarily use
several funds to account for their resources and activities. For example, a church may use
one fund for general operations, another for resources set aside to construct a new building,
and a third for its religious school.

W HAT CHARACTERIZES FUNDS?

.............................................................................................................
As suggested by the earlier reference to a ‘‘self-balancing set of accounts,’’ each fund of a
government or not-for-profit uses the accounting equation:
assets ¼ liabilities þ fund balance
This is a variation of the business accounting equation (assets ¼ liabilities þ owners’ equity).
The term fund balance replaces owners’ equity, because governments and not-for-profits
21
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22 CHAPTER 2 / FUND ACCOUNTING

may not have owners. Fund balance, like owners’ equity, is a residual and is often referred to
as net assets. Fund balance, or net assets, is the amount left to the parties with rights to the
assets after all other claims against those assets have been liquidated.
Because the basic accounting equation is the same, funds can be accounted for by the
same double-entry system of bookkeeping as businesses, and their current status and past
performance can be summarized by similar financial statements. For example, the balance
sheet of a fund can detail the specific assets, liabilities, and elements of fund balance that
underlie the accounting equation as of any point in time. A statement of revenues,
expenditures (or expenses), and other changes in fund balance can explain the reasons for
changes in fund balance during a specified period.1 A statement of cash flows can reconcile the
changes in cash between the end and the beginning of a period.

USE OF MULTIPLE FUNDS TO ACCOUNT FOR AN ENTITY Funds may seem similar to
business subsidiaries, but they are established for quite different reasons. Businesses generally
establish subsidiaries to account for their activities by product or region, to isolate certain
business risks, or to minimize their tax obligations. Governments and not-for-profits, on the
other hand, most commonly separate resources into funds to ensure that they adhere to the
restrictions placed upon them by legislators, grantors, donors, or other outside parties. For
example, a university that received a donation to be used only for scholarships would account
for it in a special scholarship fund.
Fund accounting promotes control and accountability over restricted resources. To a
lesser extent, governments and not-for-profits establish funds to account for certain activities,
often those of a business type, that are different from their usual activities. For example, a
government might account for its golf course, which operates similarly to a privately owned
course, in a fund that is separate from the one used to account for its general operations. By
accounting for these types of activities in their own accounting and fiscal entities, govern-
ments and not-for-profits are better able to control the activities’ revenues and expenditures
and to assess their overall performance.
To appreciate the relationship among two or more funds used to account for a single
organization, remember that each fund is a separate accounting entity. Thus, every transac-
tion that affects a fund must be recorded by at least one debit and one credit. Any transaction
that affects two or more funds must be accounted for as though it affected two or more
independent businesses and must be recorded individually in each fund. Suppose, for
example, that a city maintains two funds: a general fund, which accounts for its unrestricted
resources and general operations, and a utility fund, which accounts for a utility that sells
electricity to city residents and other government departments. The utility bills the other city
departments—all accounted for in the general fund—for $10,000. The following entries
would be appropriate:

Utility Fund
Accounts receivable (from general fund) $10,000
Revenue from sale of electricity $10,000
To record the sale of electricity to general fund

General Fund
Electricity expenditure $10,000
Accounts payable (to utility fund) $10,000
To record the use of electricity

1
As addressed later in the text, in government accounting ‘‘expenditures’’ are distinguished from ‘‘expenses.’’ For
now, suffice it to note that ‘‘expenditures’’ is used in connection with funds that are not accounted for on a full accrual
basis, whereas ‘‘expenses’’ is used in connection with those accounted for on a full accrual basis.
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WHAT CHARACTERIZES FUNDS? 23

BASIS OF ACCOUNTING AND MEASUREMENT FOCUS Basis of accounting determines
when transactions and events are given accounting recognition. For instance, if an entity
adopts the full accrual basis of accounting, a transaction is recognized when it has its
substantive economic impact, irrespective of when cash is received or paid. If, on the other
hand, it adopts the cash basis, the transaction is recognized only as the related cash is received
or paid. An entity’s measurement focus determines what is being reported upon—which
assets and liabilities are given accounting recognition and reported on the balance sheet.
The two concepts are closely related; the selection of one implies the selection of the
other. For example, if an entity adopts a cash basis of accounting, its measurement focus is
upon cash. Only cash is reported on its balance sheet. Correspondingly, measurement focus
also determines whether the entity reports net profit (the net increase in all economic
resources) or merely the net change in selected resource flows (such as current financial
resources, e.g., cash, short-term receivables, and short-term investments).
If an entity adopts a full accrual basis of accounting, which is required of businesses, its
measurement focus is automatically upon all economic resources, and its balance sheet
reports on all assets and liabilities, both current and noncurrent. Increases or decreases in
capital assets and long-term obligations are not recognized as revenues or expenses. Capital
assets are long-lived assets, such as land, buildings, equipment, vehicles, roads, bridges, and
streetlights. Suppose, for example, that an organization purchases a vehicle for $35,000 by
giving a note for the entire amount. The following entry is appropriate:
Vehicles $35,000
Notes payable $35,000
To record the acquisition of a vehicle
Because governments and not-for-profits may be primarily concerned with the assets
needed to satisfy current-year obligations, they may adopt a modified accrual basis of
accounting and a measurement focus on mainly short-term financial assets and liabilities for
many of their funds.2 Modified accrual is between the cash and full accrual bases. Under the
modified accrual basis used by governments, revenues and some expenditures are recognized on
a cash or near-cash basis; other expenditures are recognized on a full accrual basis. Because the
measurement focus is on current financial resources, capital assets and long-term liabilities are
excluded from the balance sheet, and net changes in short-term financial assets and liabilities are
recognized as revenues or expenditures. For example, if a government borrows $35,000 (issuing
a long-term note) and uses the proceeds to purchase a vehicle, the following entries are proper:
Cash $35,000
Proceeds from borrowing $35,000
To record the issuance of a long-term note
Expenditure for vehicles $35,000
Cash $35,000
To record the purchase of the vehicle
The government reports neither the vehicle nor the long-term note on its fund balance sheet.
Instead it records both the increase and subsequent decrease in a financial asset (cash) on the
fund’s statement of revenues and expenditures. The vehicle, in effect, is written-off (expensed)
at the time acquired. The proceeds from the note are recorded as proceeds from borrowing,
an increase in fund balance that (like a revenue) is closed to fund balance.
Governments can report their funds on different bases for different purposes. For
example, to provide a measure of the full cost of services, a government may report some
2
Although not-for-profits may adopt a modified accrual basis of accounting for internal management and control,
FASB standards require that they prepare their general-purpose external reports on a full accrual basis. In contrast,
GASB standards require governments to report certain activities on both a modified accrual and a full accrual basis.
The modified accrual basis used by governments is discussed in more detail beginning in Chapter 4.
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24 CHAPTER 2 / FUND ACCOUNTING

of its funds on a full accrual basis. To demonstrate compliance with budgetary constraints, it
may report other funds on a modified accrual basis. Businesses, of course, also use two or
more bases to account for their operations. They prepare their financial statements on a full
accrual basis, their tax returns on a basis specified by the Internal Revenue Service, and their
reports to state or federal agencies on a basis defined by the relevant regulatory authority.
Irrespective of whether an entity reports capital assets and long-term liabilities on its fund
balance sheets, it must still maintain accounting control over them. Management and
constituents need to be concerned with all the entity’s resources and obligations—not
just those reported on its balance sheet. Therefore, the entity must maintain accounting
records of all assets and liabilities and must include in its financial statements schedules that
summarize them and show the changes during the year.
Earlier we mentioned that governments and not-for-profits commonly use multiple
funds to report their activities. To reinforce the purposes of fund accounting and the
relationships among funds, we now present a simple example of a fund accounting system.
We use as our illustration a public school district, which accounts for its funds on a modified
accrual basis, with a measurement focus on current financial resources. In particular the
illustration is intended to emphasize that

Each fund is a separate accounting and fiscal entity.

Because the funds are not on a full accrual basis, some economic resources (primarily
capital assets) and obligations (primarily those that are long-term) are not reported on
the fund’s balance sheet as assets and liabilities (and hence must be accounted for either in
off-the-balance-sheet records or on statements prepared on a full accrual basis).

EXAMPLE Fund Accounting in a School District

........................................................................................................
A newly formed public school district accounts for its operations on a modified accrual basis,
with a measurement focus on current financial resources. It maintains four funds:

A general fund. This fund accounts for taxes and other unrestricted resources.

A capital projects fund. This fund accounts for the proceeds of bonds that are restricted for
the construction of buildings and other capital assets.

A debt service fund. This fund accounts for resources that are to be set aside each year to
ensure that the district has the wherewithal to make its required payments of interest and
principal on its long-term debt. It may be viewed as a savings account (or sinking fund)
for resources restricted by either the debt covenants (agreements) or by policies of the
district itself.

A special revenue fund. This fund accounts for state grants that must be used for specific
purposes.
The following is a highly aggregated summary of the district’s first year of operations:
1. The district levied $90 million of general property taxes, of which it actually collected
$88 million. It expects to collect the balance shortly after year-end. These taxes are
unrestricted; they can be used for any legitimate educational purpose. Therefore, the
district should record them in its general fund.
General fund
Cash $88
Property taxes receivable 2
Property tax revenue $90
To record property taxes
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WHAT CHARACTERIZES FUNDS? 25

2. The district received a state grant of $2 million to purchase computers. This grant is
restricted for a specific purpose and therefore must be recorded in a restricted fund, the
special revenue fund.
Special revenue fund
Cash $2
Grant revenue $2
To record a state grant restricted for the acquisition of computers

3. The district issued $120 million in long-term bonds to construct a school building. The
proceeds must be used for the intended purpose and therefore must be recorded in the
capital projects fund. Because the district is on a modified accrual basis of accounting and
current financial resources measurement focus, which excludes the recognition of both
capital assets and long-term liabilities, the proceeds from borrowing are recognized in a
revenue-type account—one that causes fund balance, rather than a liability, to increase.
Of course, the district must maintain a record of both its capital assets and long-term
obligations in supplementary ledgers or other off-the-balance-sheet lists. These assets
and liabilities are also reported in government-wide financial statements, which are
addressed in Chapter 3.
Capital projects fund
Cash $120
Proceeds from borrowing $120
To record the issuance of bonds

4. The district constructed the school building for $110 million. The construction must be
accounted for as an expenditure, rather than as a capital asset. The asset must be recorded
in a supplementary ledger or list.
Capital projects fund
Construction of building (expenditure) $110
Cash $110
To record the costs of constructing the school building

5. The district incurred $60 million in general operating expenditures, of which it actually
paid $55 million.

General fund
General operating expenditures $60
Cash $55
Accounts payable 5
To record general operating expenditures

6. Using its state grant, the district purchased computers for $1 million. As with the
construction of the building, the district recognizes the acquisition as an expenditure but
records the capital asset in a supplementary ledger or list.

Special revenue fund

Acquisition of computers (expenditure) $1
Cash $1
To record the acquisition of computers

7. The district transferred $11 million from the general fund to the debt service fund to
make the first payments of both principal and interest that are due in the following year.
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26 CHAPTER 2 / FUND ACCOUNTING

Broken into its components, this transaction is straightforward, involving simple entries
to each of two funds:
General fund
Transfer out to debt service fund $11
Cash $11
To record transfer to the debt service fund

Debt service fund

Cash $11
Transfer in from general fund $11
To record transfer from the general fund

Tables 2-1 and 2-2 summarize the transactions into balance sheets and statements of
revenues and expenditures for the three funds. To emphasize that each fund is a separate
accounting and reporting entity, combined totals are deliberately omitted.

TABLE 2-1
School District’s Funds Balance Sheet (in millions)
Special Capital Debt
General Revenue Projects Service
Assets
Cash $22 $1 $10 $11
Property taxes receivable 2
Totals $24 $1 $10 $11
Liabilities and fund balances
Accounts payable $ 5
Fund balances (net assets) 19 1 10 11
Totals $24 $1 $10 $11

TABLE 2-2
School District’s Statement of Fund Revenues, Expenditures
and Other Changes in Fund Balances (in millions)
General Special Revenue Capital Projects Debt Service
Property tax revenue $ 90
Revenue from state grant $2
Total revenues $ 90 $2
Operating expenditures $ 60
Construction of building $ 110
Acquisition of computers $1
Total expenditures $ 60 $1 $ 110
Excess of revenues over
expenditures $ 30 $1 $(110)
Other increases and decreases
in fund balances:
Transfers in/(out) $(11) $11
Proceeds from borrowing $ 120 ___
Net increase in fund balance $ 19 $1 $ 10 $11
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WHAT’S NOTABLE ABOUT EACH TYPE OF GOVERNMENTAL FUND? 27

The sections that follow present an overview of the main funds maintained by govern-
ments and not-for-profits, respectively. Bear in mind that each fund, like a subsidiary of a
corporation, is a separate accounting and fiscal entity, for which separate financial statements
can be prepared. Just as the financial statements of a corporation can be prepared on different
bases (e.g., full accrual, cash, tax, regulatory), so also can those of individual funds (e.g.,
modified accrual, full accrual). And just as the financial statements of a company’s subsidiaries
can be combined in different ways (e.g., by region, by product line, by size), so too can those of
a government or not-for-profit (e.g., by type, by dollar value, by nature of restrictions). We
address in Chapter 3 how a government’s funds may be aggregated for greater simplicity in
financial reporting.

W HAT ARE THE MAIN TYPES OF GOVERNMENTS’ FUNDS?

.............................................................................................................
Most general purpose governments engage in three broad categories of activities:

Governmental activities are those financed predominantly through taxes and inter-
governmental grants.

Business-type activities are those financed predominantly through user charges.

Fiduciary activities are those for which the government acts as a trustee or agent for
individuals, external organizations, or other governments.
Corresponding roughly to these three kinds of activities, governments classify funds into
three broad categories: governmental funds, proprietary funds, and fiduciary funds. As
shown in Table 2-3, each category contains several different types of funds, each having a
different purpose.
Governmental funds may be characterized as expendable funds, in that their resources
are received from taxes, grants, or other sources and are then spent. There is no expectation
that the funds will be reimbursed for services rendered to constituents or other departments.
By contrast, proprietary funds are said to be nonexpendable (or revolving) funds. That is,
the government may make an initial contribution to establish a proprietary fund, but
thereafter the fund is expected to ‘‘pay its own way’’ (at least in part) through customer
charges. Fiduciary funds differ from governmental and proprietary funds in that their
activities and resources benefit only parties other than the government—not the government
itself.
A government should have only one general fund, but it may have any number of the
other types of funds. For example a city may maintain a separate special revenue fund for each
restricted revenue source, a separate capital projects fund for each major capital project, and a
separate debt service fund for each issue of outstanding bonds.
We now take a comprehensive look at each of the types of funds.

W HAT'S NOTABLE ABOUT EACH TYPE OF GOVERNMENTAL FUND?

.............................................................................................................
THE GENERAL FUND The general fund should be used to account for and report all
financial resources that are not accounted for or reported in another fund.3 All funds are not
created equal; the general fund is more equal than the others. In a city or other general
purpose government, the general fund embraces most major government functions—police,
fire, street maintenance, sanitation, and administration.

3
The definitions of governmental fund types in this section are drawn from GASB Statement No. 54, Fund Balance
Reporting and Governmental Fund Type Definitions (February 2009), paras. 29, 30, and 33–35.
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28 CHAPTER 2 / FUND ACCOUNTING

TABLE 2-3
The Fund Structure of State and Local Governments
Governmental Funds
Purpose: To account for and report governments’ operating and financing activities financed
predominantly through taxes and intergovernmental grants.
Basis of accounting/measurement focus: Modified accrual/current financial resources
There are five kinds of governmental funds:

General fund—to account for and report all financial resources not accounted for and reported in another
fund

Special revenue funds—to account for and report the proceeds of specific revenue sources that are restricted
or committed for specified purposes other than debt service or capital projects (e.g., gas tax revenues
required to be used for road repairs)

Debt service funds—to account for and report financial resources that are restricted, committed, or assigned
to expenditure for principal and interest

Capital projects funds—to account for and report financial resources that are restricted, committed, or
assigned to expenditure for capital outlays, including the acquisition or construction of capital facilities,
such as buildings and highways, and other capital assets

Permanent funds—to account for and report resources restricted in that only the earnings on investments,
not the principal, may be used to support the reporting government’s programs for the benefit of the
government or its citizenry (e.g., maintenance of a public cemetery or park)
Proprietary Funds
Purpose: To account for and report governments’ activities that are similar to those carried out in the
private sector and financed predominantly through user charges
Basis of accounting/measurement focus: Full accrual/economic resources
There are two kinds of proprietary funds:

Enterprise funds—to account for and report business-type activities that serve the public at large (e.g., an
electric utility)

Internal service funds—to account for and report goods and services provided to departments of the same
government (e.g., a centralized purchasing function or motor pool).
Fiduciary Funds
Purpose: To account for and report resources held by governments as trustees or agents for another party
or parties
Basis of accounting/measurement focus: Full accrual/economic resources
There are two kinds of fiduciary funds:

Trust funds, including

Pension (and other employee benefit) trusts—to account for and report resources accumulated to pay
pension, healthcare, and other benefits to the government’s retired or disabled employees (e.g., a local
government’s pension plan for its employees)

Investment trusts—to account for and report investment pools in which other governments participate
(e.g., a state government pool open to local governments within the state)

Private purpose trusts—to account for and report resources held for individuals or external organiza-
tions (e.g., a scholarship fund for employees’ children, funded by a donation from a citizen)

Agency funds—to account for and report resources held on a short-term basis on behalf of individuals,
organizations, or other governments (e.g., taxes collected on behalf of another government). These funds
have only assets and liabilities—no revenues or expenses.

Why does one single fund cover so many functions? Recall the rationale for fund
accounting. Funds are established mainly to ensure that governments adhere to resource
restrictions. A government’s fund structure rarely mirrors its organizational structure. Funds
divide a government into categories of resource restriction, not functional departments or
operations. To keep their accounting systems as simple as possible, governments should
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WHAT’S NOTABLE ABOUT EACH TYPE OF GOVERNMENTAL FUND? 29

establish only the minimum number of funds necessary to ensure legal compliance or efficient
administration. Governments finance their general operations mainly with unrestricted
resources, such as property taxes. Therefore, they can legally intermingle these resources
and can properly account for all activities financed with unrestricted resources in a single
fund. However, governments also may account for and report restricted resources in the
general fund when a separate fund is not required by law or the governing body.
As noted in Table 2-3, the general fund uses a modified accrual basis of accounting and a
measurement focus on current financial resources. This basis of accounting and measurement
focus are discussed in more detail in Chapter 4. For now, recall that a modified accrual basis
falls between the cash basis and the full accrual basis. Thus, the general fund records and
reports on its balance sheet cash and other current financial resources, including primarily
taxes receivable, accounts receivable, and short-term investments of unrestricted resources,
but not capital assets or long-term debt. Obviously a general-purpose government, such as a
city, owns police cars, fire equipment, computers, and buildings, and it probably financed
some of its capital assets with long-term debt. If the general fund were accounted for on a full
accrual basis (economic resources measurement focus), these assets and liabilities would be
reported on the fund’s balance sheet. Instead, they have apparently been written off as
acquired (and presumably listed in off-the-balance sheet ledgers or other records). However,
as shown in Chapter 3, capital assets and long-term debt associated with the general fund or
other governmental funds are reported in financial statements that are prepared on the full
accrual basis for the government as a whole.

SPECIAL REVENUE FUNDS Special revenue funds are established to account for and report
the proceeds of specific revenue sources that are restricted or committed4 for specified
purposes other than debt service or capital projects. Examples of typical restrictions or
commitments include

Gasoline tax revenues that must be used for highway maintenance

A state law-enforcement grant that must be used to train police officers

Private donations that must be used to maintain parks and other recreational facilities

Lottery fund proceeds committed to expenditures for education
Special revenue funds use the same basis of accounting and measurement focus as the
general fund and, indeed, all governmental funds. Accordingly, almost all of the guidelines set
forth in this text for the general fund also apply to special revenue funds and other
governmental funds.

DEBT SERVICE FUNDS Debt service funds are maintained to account for and report
financial resources that are restricted, committed, or assigned to expenditure for principal
and interest, including financial resources that are being accumulated for principal and
interest that are maturing in future years. Debt service funds should be used to report
resources if legally mandated. They have much in common with sinking funds (resources set
aside to retire debt) maintained by businesses.
The balance sheet of a debt service fund does not include the obligation for the debt
being serviced. The purpose of the fund is to account for the resources being accumulated to
service the debt—not the debt itself. Also, debt service funds are governmental funds, and no
governmental fund records long-term obligations. As shown in the next chapter, long-term
debt, for which resources are being accumulated in a debt service fund, is reported only in full
accrual financial statements, for the government as a whole and in supplementary schedules.

4
The terms restricted, committed, and assigned denote different strengths of the constraints placed on how govern-
mental fund resources can be used. We address the distinctions in Chapter 3.
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30 CHAPTER 2 / FUND ACCOUNTING

The one exception is interest and principal that have matured and are therefore current
obligations. They are reported in a debt service fund as matured interest payable or matured
bonds payable. But this exception is of little practical import. On the day the interest or
principal matures, it should be paid and the obligation satisfied. Therefore, a liability for
interest or principal should be reported in year-end fund financial statements only when
payment is due but has been delayed.
Debt service funds derive their resources from other funds (e.g., transfers from the
general fund) or from taxes or fees dedicated to debt service. Fund resources are expended to
pay principal and interest. Governments commonly invest accumulated resources for debt
service in commercial paper, treasury bills, and other financial instruments that, although
secure, still provide a reasonable return. Typically, therefore, many debt service fund
transactions relate to the purchase and sale of marketable securities and the recognition
of investment earnings and related costs.

CAPITAL PROJECTS FUNDS Capital projects funds account for and report financial
resources that are restricted, committed, or assigned to expenditure for capital outlays,
including the acquisition or construction of capital facilities and other capital assets, such as
buildings, highways, and equipment. Governments often issue bonds to finance a specific
project. The resources received must be placed in a capital projects fund and expended for
that project. Capital projects funds typically derive their resources from the proceeds of
bonds. However, they may also receive resources that were initially received by other funds
and subsequently committed or assigned for the acquisition of capital assets.
Just as debt service funds account for resources accumulated to service a debt—but not
the debt itself—so, too, capital projects funds account for resources that have been set aside to
purchase or construct capital assets, but not the assets themselves. The assets, whether in the
form of construction in progress or completed projects, are reported only in the financial
statements for the government as a whole and in supplementary schedules. As with the
resources accumulated to service their debts, governments must invest any excess cash that is
awaiting expenditure for capital projects. Therefore, many transactions of typical capital
projects funds, like those of debt service funds, relate to investment activities.

PERMANENT FUNDS Permanent funds are a type of trust fund, but they are categorized as
governmental funds, not fiduciary funds. They are similar to private purpose trusts (fiduciary
funds) in that usually only the income from fund investments, not the principal, may be spent.
They differ, though, in that programs financed by permanent funds are for the benefit of the
government itself or its citizenry, whereas the activities of private purpose trusts—and all
fiduciary funds—benefit individuals, private organizations, or other governments.
Suppose, for example, that a government received a donation to support one of its parks.
The resources received were to be invested, and only the income, not the principal, could be
expended. The government establishes a permanent fund to account for the donation (the
principal). As income is earned, it is transferred to a special revenue fund, from which it is used
for the intended purpose. By contrast, if the government received a donation to provide
scholarships to its employees’ children, it would report the gift in a private purpose trust
(fiduciary) fund.

W HAT’S NOTABLE ABOUT EACH TYPE OF PROPRIETARY FUND?

.............................................................................................................
Proprietary funds—enterprise funds and internal service funds—are used to account for
activities that are operated in a manner similar to private business enterprises and when a
government’s intent is to recover costs primarily through user charges. Because a typical
objective in providing the service is to break even at least, the government officials responsible
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WHAT’S NOTABLE ABOUT EACH TYPE OF PROPRIETARY FUND? 31

for the activity require the same types of financial information as their business counterparts.
For example, they need data on the full cost (including depreciation) of the services provided
so that they can establish prices. Outsiders, such as tax or rate payers, concerned with the
activity’s performance or financial position, need the same general information as corporate
shareholders. For this reason, proprietary funds are accounted for in essentially the same
manner as in private businesses. The funds employ the full accrual basis of accounting, and
their measurement focus is on all economic resources. Therefore, their financial statements,
unlike those of governmental funds, report capital assets, long-term debt, and depreciation, as
discussed further in Chapter 3.

ENTERPRISE FUNDS Enterprise funds account for services provided to the public at large
and may include these services:

Utilities, such as electric, gas, and water

Golf courses

Hospitals

Mass transportation

Parking garages

Airport and harbor facilities

Housing authorities.
Many government enterprises are financed similarly to businesses. A government enterprise
does not sell stock to the general public, but it may issue bonds (called revenue bonds).
Revenue bond principal and interest are payable exclusively out of revenues of the fund
itself—not out of the general revenues of the government at-large. Therefore, the fund’s
resources must be kept intact and cannot be commingled with those of other funds.

INTERNAL SERVICE FUNDS Internal service funds account for the provision of goods or
services to other departments within the same government (or, occasionally, to other
governments). They bill the receiving departments at rates intended to cover the cost of
the goods or services. Although there are no specific guidelines as to which with-
in-government activities should be accounted for in internal service funds, the following
are examples:

A maintenance and repair service for the cars and trucks of the police department, fire
department, sanitation department, etc.

A motor pool that acts as a within-government rental car agency

An electronic data-processing department that services other government departments

A store that sells office supplies to the other government departments

A print shop that provides government-wide printing services.
Internal service funds are typically established with resources contributed from the general
fund or another fund and thereafter are expected to be self-sustaining. As such, they use full
accrual accounting and the economic resources measurement focus. Most of their transac-
tions are with other funds, and their accounting is relatively straightforward, as long as each
fund is seen as a separate accounting entity. When an internal service fund bills another
department, it recognizes a revenue and a receivable from another fund. Simultaneously, the
fund that accounts for the other department records an expenditure or expense and a payable
to the internal service fund. Most of the departments to which an internal service fund sells its
goods or services are likely to be accounted for in the general fund or an enterprise fund. This
is primarily because most government operations (as opposed to accumulations of resources
for specific purposes) are accounted for in those funds.
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32 CHAPTER 2 / FUND ACCOUNTING

W HAT'S NOTABLE ABOUT EACH TYPE OF FIDUCIARY FUND?

.............................................................................................................
Unlike governmental and proprietary funds, fiduciary funds only benefit parties other than
the government itself, including employees, other governments, and specific individuals,
corporations, or not-for-profits. Their activities do not result in revenues or expenses to the
government—only additions and deductions to their own net assets. Therefore, they are
reported only in fiduciary fund financial statements. They are not included in the financial
statements for the government as a whole.

TRUST FUNDS Kohler’s Dictionary for Accountants defines a trust fund as a ‘‘fund held by one
person (trustee) for the benefit of another, pursuant to the provisions of a formal trust
agreement.’’5 There are three types of trust funds:

Pension (and other employee benefit) trust funds provide retirement income, disability
income, health care insurance, and other benefits to retired or disabled employees of the
government and their beneficiaries (e.g., a local government’s pension plan for its
firefighters).

Investment trust funds, which are similar to mutual funds, benefit the parties, usually
other governments, that have entrusted their resources to the fund (e.g., an investment
pool maintained by one government for other governments).

Private purpose trust funds encompass all other trust funds that benefit specific
individuals, other governments, external organizations, or businesses (e.g., a scholarship
fund for children of a government’s employees, funded by a donation from a citizen).
Trust funds commonly hold their resources in noncurrent as well as current investments, and
fund performance is important to beneficiaries and fund managers. Therefore, trust funds use
full accrual accounting, and their measurement focus is on economic resources.

AGENCY FUNDS Agency funds are used to account for assets held, usually for a short period,
on behalf of other governments, funds, or individuals. Most commonly they are established to
maintain control over

Taxes collected by one government for the benefit of another

Special assessments collected to repay debt that the government services but for which it
is not responsible

Refundable deposits

Pass-through grants—those requiring a government (e.g., a state) to distribute funds to
other parties (e.g., school districts or individuals), but for which the government has no
financial involvement and for which it performs no significant administrative functions,
such as selecting recipients or monitoring performance.
Custodial in nature, agency funds are not used to account for significant government
operations. Consequently, agency funds are a student’s delight—entities of the utmost
simplicity. Their balance sheets show only assets (commonly, cash and investments) and
liabilities (the amounts owing to the beneficiaries). Assets always equal liabilities, and hence
there are no net assets. Accordingly, governments need not prepare a statement of revenues
and expenses.

5
W. W. Cooper and Yuji Ijiri (eds.), Kohler’s Dictionary for Accountants, 6th ed. (Englewood Cliffs, NJ: Prentice-Hall,
Inc., 1983), p. 516.
E1C02 03/29/2010 9:41:37 Page 33

QUESTIONS FOR REVIEW AND DISCUSSION 33

HOW DO THE FUNDS OF NOT-FOR-PROFITS

DIFFER FROM THOSE OF GOVERNMENTS?
.............................................................................................................
Although the GASB mandates fund-based reporting for governments, the FASB imposes no
similar requirement upon not-for-profits. As stressed earlier, fund accounting is an expedient
means of control that helps ensure that governments or other organizations use resources
only for the purposes for which they have been dedicated. But fund accounting is not the only
means. After all, private businesses also must account for resources that are restricted (e.g.,
income taxes withheld from employees, sales taxes collected from customers, advance
payments on government contracts, proceeds from bond issues that must be spent on specific
projects). Yet businesses do not employ fund accounting.
Nevertheless, for purposes of internal accounting and control, most not-for-profits
employ fund accounting, and they maintain funds that are comparable to those of govern-
ments. Most not-for-profits maintain a current fund, which is like a government’s general
fund. Similarly, most not-for-profits maintain one or more current restricted funds, which
are, in essence, special revenue funds. They may also maintain, as needed, funds to account for
resources that have been set aside for the acquisition of capital assets and for the repayment of
debt. Many colleges and universities categorize all funds having to do with capital assets and
the related debt as plant funds. These include an unexpended plant fund (similar to a capital
projects fund), a retirement of indebtedness fund (analogous to a debt service fund), and an
investment in plant fund (which accounts for both capital assets and related long-term debt).
Although the FASB does not require fund accounting, it requires that not-for-profits
classify their net assets into three categories based on the restrictions of donors:

Unrestricted

Temporarily restricted

Permanently restricted.
The classification is based exclusively on the restrictions of donors, rather than, for example,
on those of banks or other lenders, because donors are the prime group of not-for-profit
statement users.
Temporarily restricted resources are those that must be used for a specific purpose (e.g.,
to support donor-designated programs or activities) or that cannot be spent until some time
in the future (e.g., when a donor makes good on a pledge). Permanently restricted resources
are typically endowments, only the income from which can be spent.
FASB accounting standards for not-for-profits are generally similar to business stan-
dards. However, the FASB imposes some accounting and reporting requirements that are
unique to not-for-profits. We devote Chapters 12 and 13 to those standards, the form and
content of not-for-profit financial statements, and other issues that are specific to
not-for-profits.
In Chapters 3 through 11, we focus on government accounting and financial reporting. In
Chapter 15, we discuss how the financial statements and other information reported for
governments and not-for-profits may be used to help assess their financial position and
economic condition.

Q UESTIONS FOR REVIEW AND DISCUSSION

............................................................................................................
1. Distinguish between funds as the term is used in 2. In what way, if any, does the accounting equation
government and not-for-profit accounting as as applied in government and not-for-profit
contrasted with business accounting.
E1C02 03/29/2010 9:41:37 Page 34

34 CHAPTER 2 / FUND ACCOUNTING

accounting differ from that as applied in business
accounting?
3. Upon examining the balance sheet of a large
city, you notice that the total assets of the 6.
general fund far exceed those of the combined
total of the city’s 10 separate special revenue
funds. Moreover, you observe that there are no
funds for public safety, sanitation, health and 7.
welfare, and general administration—all impor-
tant functions of the government. Why do you 8.
suppose the city hasn’t attempted to ‘‘even out’’
9.
the assets in the funds? Why does it not main-
tain funds for each of its major functional areas?
10.
4. Why are there generally no capital projects (work
in progress or completed assets) in governments’
capital projects funds? Why are there generally
no long-term debts in debt service funds?
5. The balance sheets of both enterprise funds and
internal service funds report long-lived assets
and long-term debt. What does that tell you
about the funds’ measurement focus and basis of
accounting? Explain.
As emphasized later in this text, depreciation is
recorded in proprietary funds—but not in gov-
ernmental funds. What is the rationale for
recording depreciation in proprietary funds?
What are fiduciary funds? What are two main
types? What is the distinction between them?
What is ‘‘permanent’’ about a permanent fund?
What is an agency fund? Why is it the easiest
fund for which to account?
Distinguish among the three categories of re-
strictiveness into which the net assets of
not-for-profit organizations must be separated
for purposes of external reporting. Explain. By
whom must restrictions be imposed for re-
sources to be considered restricted?

E XERCISES AND PROBLEMS

.........................................................................................................
2-1 ___ 1. Revenue to be recognized in a. 0
The following relate to the town of Coupland an enterprise fund b. 140
(in thousands): ___ 2. Revenue to be recognized in c. 900
special revenue funds d. 1,260

Equipment used in a vehicle repair
___ 3. Bonds payable to be recog- e. 1,040
service that provides service to other
nized in the general fund
departments on a cost-reimbursement f. 1,400
basis. The equipment has a 10-year ___ 4. Bonds payable to be recog-
g. 2,200
life with no salvage value. $1,400 nized in enterprise funds
h. 4,000

Property taxes levied and collected 6,300 ___ 5. Depreciation expenditure to
be recognized in the general i. 6,300

Hotel taxes (restricted for promotion
fund j. 8,000
of tourism) collected 1,200
___ 6. Depreciation expense to be k. 8,500

Proceeds of bonds to build a parking
recognized in internal service l. 10,400
garage that must be repaid from
funds
user charges 4,000
___ 7. Revenue to be recognized in

Proceeds of general obligation bonds
an internal service funds
to finance construction of a new city
hall. The building, which was ___ 8. Revenue to be recognized in
completed during the year, has a the general funds
useful life of 30 years, with no ___ 9. Long-lived assets to be rec-
salvage value. 9,000 ognized in the general fund

Proceeds of a federal grant to hire ___ 10. Long-lived assets to be rec-
additional police officers 1,000 ognized in internal service

Fees collected from customers by the funds
electric utility 8,000 2-2

Refer to the two lists below. Select the appropriate 1. Oak Township issued the following bonds
amounts from the lettered list for each item in the during the year:
numbered list. An amount may be selected once,
more than once, or not at all.
E1C02 03/29/2010 9:41:38 Page 35

EXERCISES AND PROBLEMS 35

Bonds to acquire equipment Property taxes $50,000,000
for a vehicle repair service A federal grant to acquire
accounted for in an inter- police cars 400,000
nal service fund $3,000,000 Hotel taxes, which must be
Bonds to construct a new city used to promote tourism 3,000,000
hall $8,000,000 Proceeds of bonds issued to
Bonds to improve its water improve the city’s electric
utility, which is accounted utility 12,000,000
for in a enterprise fund $9,000,000
The amount of debt to be reported in the The amount that the city should most likely
general fund is report as revenue in its special revenue fund is

a. $0 a. $400,000
b. $3,000,000 b. $3,000,000
c. $8,000,000 c. $3,400,000
d. $20,000,000 d. $15,400,000
e. $65,400,000
2. Oak Township should report depreciation in
which of the following funds: 6. A city issues $20 million of general obligation
bonds to improve its streets and roads. In
a. general fund
accordance with the bond covenants, it sets
b. special revenue fund aside $1 million to help ensure that it is able to
c. internal service fund meet its first payment of principal and $0.1
d. capital projects fund million for its first payment of interest. The
amount of liability that the city should report
3. Assuming that Bevo County receives all of its in its debt service fund is
revenues from unrestricted property taxes, it is
most likely to account for the activities of its a. $0
police department in its b. $18.9 million
c. $19 million
a. police department fund
d. $20 million
b. police enterprise fund
c. property tax fund 7. During the year, Brian County collects $12
d. general fund million of property taxes on behalf of Urton
Township. Of this amount, it remits $10 mil-
4. The city of Alpine incurred the following costs lion to the township, expecting to remit the
during the year in its property tax collection balance shortly after the end of its fiscal year.
department: The amount of revenue that the County
Purchase of computer equipment $ 10,000 should report is
Salaries and wages $400,000 a. $0
Purchase of electricity from the b. $2 million
city-owned electric utility $ 40,000
c. $8 million
Purchase of supplies, all of
which were used during d. $10 million
the year $ 10,000 8. The City of Round Lake receives a contribu-
As a consequence of these transactions, the tion of $20 million. The donor stipulates that
amount that Alpine should report as expendi- the money is to be invested. The principal is to
tures in its general fund is remain intact, and the investment proceeds are
to be used to support a city-owned nature
a. $400,000 center. The city should report the contribu-
b. 410,000 tion in a
c. 450,000 a. special revenue fund
d. 460,000 b. permanent fund
5. Grove City received the following resources c. fiduciary fund
during the year: d. agency fund
E1C02 03/29/2010 9:41:38 Page 36
36 CHAPTER 2 / FUND ACCOUNTING
9. A city receives a $30 million contribution. The
donor stipulates that the money is to be in-
vested. The principal is to remain intact, and
the investment proceeds are to be used to
provide scholarships for the children of city
employees. The contribution should be reported
as revenue of a
a. special revenue fund
b. permanent fund
c. fiduciary fund
d. agency fund
10. The Summerville Preparatory School (a pri-
vate school) receives a donation of $14 million.
The donor stipulates that the entire amount
must be used to construct a new athletic field
house. The School should classify the dona-
tion as
a. unrestricted
b. temporarily restricted
c. permanently restricted
d. semi-restricted
2-3
A special district’s balance sheet may not capture its
economic resources and obligations.
A special district accounts for its general fund (its
only fund) on a modified accrual basis. In a particular
period, it engaged in the following transactions.
a. It issued $20 million in long-term bonds.
b. It acquired several tracts of land, at a total
cost of $4 million, paying the entire amount
in cash.
c. It sold a portion of the land for $1 million,
receiving cash for the entire amount. The
tract sold had cost $0.8 million.
d. It repaid $2 million of the bonds.
e. It lost a lawsuit and was ordered to pay $9
million over three years. It made its first
cash payment of $3 million.
1. Prepare journal entries to record the transac-
tions in the general fund.
2. Based on your journal entries, prepare a bal-
ance sheet and a statement of revenues, expen-
ditures, and other changes in fund balance.
3. Comment on the extent to which the balance
sheet captures the district’s economic re-
sources and obligations. How can you justify
such a balance sheet?
4. Comment on the extent to which the state-
ment of revenues, expenditures, and other
changes in fund balance captures the district’s
cost of services. How can you justify such a
financial statement?
2-4
Funds are separate fiscal and accounting entities, each
with its own self-balancing set of accounts.
The newly established Society for Ethical
Teachings maintains two funds—a general fund
for operations and a building fund to accumulate
resources for a new building. In its first year, it
engaged in the following transactions.
a. It received cash contributions of $200,000,
of which $40,000 was restricted for the
acquisition of the new building.
b. It incurred operating costs of $130,000, of
which it paid $120,000 in cash.
c. It earned $3,000 of interest (the entire
amount received in cash) on resources re-
stricted for the acquisition of the new
building.
d. It transferred $17,000 from the operating
fund to the new building fund.
e. It paid $12,000 in fees (accounted for as
expenses) to an architect to draw up plans
for the new building.
1. Prepare journal entries to record the transac-
tions. Be certain to indicate the fund in which
they would be made.
2. Prepare a statement of revenues, expenditures,
and other changes in fund balances and a
balance sheet. Use a two-column format,
one column for each of the funds.
2-5
Typical transactions can often be identified with specific
types of funds.
Boxer City maintains the following funds:

General

Special revenue

Capital projects

Debt service

Enterprise

Internal service

Permanent

Agency
For each of the following transactions, indicate the
fund in which it would most likely be recorded:
a. The city collects $3 million of taxes on
behalf of the county in which it is located.
E1C02 03/29/2010 9:41:38 Page 37
b. It spends $4 million to pave city streets,
using the proceeds of a city gasoline tax
that is dedicated for road and highway
improvements.
c. It receives a contribution of $5 million. Per
the stipulation of the donor, the money is to
be invested in marketable securities, and the
interest from the securities is to be used to
maintain a city park.
d. It collects $800,000 in landing fees at the
city-owned airport.
e. It earns $200,000 on investments that have
been set aside to make principal payments
on the city’s outstanding bonds. The bonds
were issued to finance improvements to the
city’s tunnels and bridges.
f. It pays $4 million to a contractor for work
on one of these bridges.
g. It pays $80,000 in wages and salaries to
police officers.
h. It purchases, from an outside supplier,
$40,000 of stationery to ‘‘sell’’ to its various
operating departments.
2-6
Each fund must account for interfund activity as if it
were a separate accounting entity.
The newly formed Buffalo School District
engaged in the following transactions and other
events during the year:
a. It levied and collected property taxes of
$110 million.
b. It issued $30 million in long-term bonds to
construct a building. It placed the cash
received in a special fund that was set aside
to account for the bond proceeds.
c. During the year, it constructed the building
at a cost of $25 million. It expects to spend
the $5 million balance in the following year.
The building has an estimated useful life of
25 years.
d. It incurred $70 million in general operating
costs, of which it paid $63 million. It expects
to pay the balance early the following year.
e. It transferred $12 million from its general
fund to a fund established to account for
resources that were set aside to service the
debt. Of this amount, $10 million was for
repayment of the debt; $2 million was for
interest.
f. From the special fund established to service
the debt, it paid $2 million in interest and $6
million in principal.
EXERCISES AND PROBLEMS 37
g. It collected $4 million in hotel taxes re-
stricted to promoting tourism. Because
the resources were restricted, they were
accounted for in a special restricted fund.
During the year, the district spent $3 mil-
lion on promoting tourism.
h. The district established a supplies store,
to provide supplies to the district’s vari-
ous departments, by transferring $4 mil-
lion from the general fund. It accounted
for the store in a proprietary fund. During
the year, the store purchased (and paid
for) $2 million in supplies. Of these, it
‘‘sold’’ $1 million, at cost (for cash), to
departments accounted for in the general
fund. During the year, these departments
used all of the supplies that they had
purchased.
1. Prepare journal entries to record the transac-
tions and other events in appropriate funds.
Assume that governmental funds are
accounted for on a modified accrual basis,
and focus only on current financial resources
(and, therefore, do not give balance sheet
recognition to either capital assets or long-
term debt). Proprietary funds are accounted
for on a full accrual basis.
2. Prepare a combined balance sheet—one that
has a separate column for each of the funds
that you established.
3. Prepare a combined statement of revenues,
expenditures, and changes in fund balances
for all governmental funds—one column for
each fund. Prepare a separate statement of rev-
enues, expenses, and changes in fund balances
for any proprietary funds that you established.
2-7
Long-term assets and liabilities are denied recognition
on funds statements.
Entrepreneurs Consultants, a state agency,
was established to provide consulting services to
small businesses. It maintains only a single general
fund and accounts for its activities on a modified
accrual basis. During its first month of operations,
the association engaged in, or was affected by, the
following transactions and events:
a. It received an unrestricted grant of
$100,000.
b. It purchased five computers at $2,000 each.
c. It paid wages and salaries of $6,000.
d. It borrowed $24,000 from a bank, to enable
it to purchase an automobile.
e. It purchased the automobile for $24,000.
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38 CHAPTER 2 / FUND ACCOUNTING

f. It made its first payment on the note— Liabilities and fund balance:
interest of $200. Bonds payable $1,700
g. It destroyed one of its computers in an Fund balance
accident. The computer was not insured. Restricted for capital projects $ 600
1. Prepare journal entries in the general fund to Restricted for debt service 200
record each of the transactions or other events. Unrestricted 1,600 2,400
2. Prepare a balance sheet and a statement of Total liabilities and fund
revenues, expenditures, and changes in fund Balance $4,100
balance for the general fund.
The fund balance restricted for debt service repre-
2-8 sents entirely principal (not interest) on the bonds
The more complete presentation is not always the easier payable.
to understand. 1. Recast the balance sheet, as best you can, into
Bertram County maintains a fund account- separate balance sheets for each of the funds
ing system. Nevertheless, its comptroller (who that are apparently maintained by the county.
recently retired from a position in private indus- Assume that the county uses a modified accrual
try) prepared the following balance sheet (in basis of accounting that excludes recognition
millions): in its funds of both capital (fixed) assets and
long-term debt. Assume also that cash and
investments are divided among the funds in
Assets: proportion to their fund balances.
Cash $ 600 2. In your opinion, which of the two presenta-
Investments 1,800 tions gives the reader a more complete picture
Construction in progress 500 of the county’s financial status? Why? Which
Fixed assets 1,200 presentation is easier to understand?
Total assets $4,100